Thoughts from Cityscape

Wed, 2009-06-24 16:24

I attended an event this morning held by Cityscape Connect called "Looking Beyond the Crisis." I posted some quotes from the event live to the Retail Traffic twitter. I thought I'd take a minute to put some of these quotes into context.

Overall, the mood was far more pessimistic than I had expected. There was no notion of "green shoots." If anything, all the panelists expected commercial real estate to get much worse before it gets better. There was widespread belief that while the government's programs may be working to stabilize the banks and easing panic, the financial system is far from healthy. The programs are propping up the institutions and prolonging the process of recovery. Marshall blasted the government for not pursuing a solution like the Resolution Trust Corp. or using the FDIC more aggressively and said instead the U.S. was opting for a slow and painful process. As Marshall put it, "Instead of taking the model that worked in the 1990s, we're taking the band aid of slowly and torturing the economy." Hannon also said that TARP and TALF have had "no effect" on commercial real estate as far as he could tell.

David Lynn had a slightly more positive spin. He also expressed skepticism that the recovery could follow the same path as what happened with commercial real estate in the 1990s, especially with fundamentals continuing to erode. Roughly, he talked about the economy slowly recovering in 2010, jobs finally turning around in 2011 and perhaps commercial real estate being poised to grow in 2012. Lynn also argued that programs like PPIP and the other TALF and TARP measures need more time before we draw conclusions.

Aside from the discussions of government policy, there was a consensus that banks largely are trying to delay the days of reckoning when they will have to recognize losses and writedowns by extending loans as much as they can. The phrase "pretend and extend" came up more than once, as in, banks are pretending that borrowers can pay off their loans and therefore granting extensions to them. However, no one thinks that can go on forever. As Barone described the process of dealing with troubled borrowers, "Banks are granting extensions at low rates and hoping the economy recovers quickly enough to get the loans performing. But things have gotten worse instead of better." Lynn agreed that banks "are playing for time" and waiting for a value floor. But right now no one really knows what commercial real estate values are because the volume of investment sales transactions is too low to truly draw conclusions. All anyone knows is that cap rates are much higher than they were at the peak of the market in 2007--perhaps as much as 300 to 350 basis points. But by not foreclosing on troubled loans, all this process is doing is keeping values of commercial mortgages at "unsustainable levels." At some point, the losses need to be realized. So panelists expected the long awaited boom in distress to materialize in 2010.

And with so much uncertainty on existing loans, lenders are being extremely cautious with new ones. Loan to value ratios may be as low as 50 percent. The largest financing any of the panelists had seen done in recent months was about $75 million. Marshall said, "Lenders are only taking safe risks and they'll only feel comfortable to do more when they know commercial real estate values have hit a bottom."

Lastly, the panelists didn't think the CMBS market would ever come back the way we saw it at the peak of the market. It may come back in a simplified and diminished form--but even that will take four to six years. That leaves a giant hole on the funding side that no one quite knows what will fill. So ultimately it is the combination of a giant funding gap, the deleveraging that is occurring and the drop in property values that is making the situation so troubling now.